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Last week, we learned that an impressive slate of Silicon Valley investors was pouring $133 million into Basis, a company that aims to create a cryptocurrency with a stable value against the dollar.

It's easy to see why investors would be excited about a project like this. If successful, it would provide all the benefits of conventional cryptocurrencies without the volatility that plagues bitcoin and its competitors today. Demand for such a cryptocurrency could easily outstrip demand for conventional cryptocurrency, since volatility is one of their big weaknesses.

But there's no guarantee that the Basis project will succeed. Lots of people have tried to create stablecoins in the past, with generally poor results.

Today's most widely used stable cryptocurrency, called Tether, claims to back each unit of its currency with a dollar of hard currency reserves. However, the company has a poor transparency record, causing critics to wonder if Tether might not actually have reserves backing all of the cryptocurrency in circulation as it claims.

Basis is taking a different, more ambitious approach to the stablecoin problem. Basis coins won't be directly backed by dollars or any other asset. Instead, the Basis blockchain will attempt to adjust the supply of Basis coins over time to maintain a peg to the dollar, much as foreign central banks expand and contract their own money supplies to maintain a stable currency value.

The Basis network doesn't exist yet—the 10-person team expects to launch it in the coming months. All we have now is a white paper describing the team's plans. And that white paper does not give us a whole lot of confidence that the team has figured out how to succeed where previous projects have failed.

The Basis stablecoin may manage to track the dollar in value for a certain period of time—especially if it's backed by a $133 million warchest. But if confidence starts to falter, the whole project could collapse.

What it takes to create a stablecoin

The simplest way to create a cryptocurrency with a stable value—in dollar terms—is to directly back it with dollars. The big downside to this approach is that some organization needs to have custody of the dollars. That runs counter to the decentralist philosophy of most cryptocurrency projects. There's a danger that the intermediary could prove to be untrustworthy, refusing to redeem coins and running off with customer funds instead. Centralization also makes it easier for governments to regulate cryptocurrencies or shut them down altogether.

Further Reading

So in recent years, cryptocurrency enthusiasts have been searching for a way to build a cryptocurrency with a stable value without relying on a centralized entity to hold conventional funds as backing.

To do that, a decentralized cryptocurrency needs to solve three problems in order to maintain a stable value against the dollar (or any other reference asset):

A decentralized way for the network to know the current exchange rate between dollars and the cryptocurrency.

A way for the network to push the value of the cryptocurrency down when it rises above $1.

A way for the network to push the value of the cryptocurrency up when it falls below $1.

The first problem seems solvable. Like a number of other stablecoin projects, Basis plans to use an on-chain consensus mechanism to establish an official exchange rate between Basis and dollars at any given point in time. Anyone will be able to vote on the current exchange rate. The system will choose the median value of these votes as the official exchange rate. A system of financial rewards and punishments—the details of which are still under development—will dissuade people from trying to game the system.

The second problem—preventing excessive appreciation of coin values—is easy to solve. If the value of the stablecoin rises too much, the system can create additional coins and introduce them into circulation.

The third problem is the hard one: how to prop up the value of the coin if it falls below $1. If the coin were backed by conventional dollars, this could be done by using dollar reserves to buy up coins. But there's no way to store dollars directly in a blockchain. So a decentralized stablecoin system needs some other asset it can sell to prop up the coin's value.

Possible fixes

As this great article by Haseeb Qureshi explains, there are basically two options here. One is to have the coins backed by another existing cryptocurrency, such as bitcoins or Ethereum's ether. The system might hold $1 of ether in reserve for every unit of the stablecoin that's put into circulation. If the price of the stablecoin falls below par, the system can use the ether to buy up coins until the price gets back to $1.

The problem, of course, is that ether itself doesn't have a stable value. If ether's value falls, the system will become insolvent. So in practice, systems like this tend to require users to deposit more than $1 worth of backing assets for every $1 of stablecoin that gets issued. Still, this scheme will break if the backing asset is too volatile. For example, if the system requires a $2 ether deposit for every $1 of stablecoins issued, then the system could become insolvent if ether's value falls by more than 50 percent.

The other option uses an approach first outlined by Robert Sams in a scheme called Seigniorage Shares. Seigniorage is the profit that a central bank makes when it issues new units of currency. The basic idea of Seigniorage Shares is that, during periods of falling demand, the system props up the value of the stablecoin by essentially selling future seigniorage profits—that is, the value of coins that will be created during later expansions of the money supply.

The scheme outlined in the Sams white paper uses two different types of token on the same blockchain, called coins and shares, respectively. Coins are designed to have a stable value over time. Shares, which fluctuate in value, entitle the owner to a share of the system's future seigniorage profits.

When the price of a coin rises above $1, the system responds by creating new coins and using them to buy shares, pushing the value of coins back down to $1. This works like a stock buyback, pushing the value of the remaining shares up. If demand for coins is rising over time, then the value of shares will grow over time, making them an attractive investment opportunity.

If the price of a coin falls below $1, the system performs the opposite operation, issuing new shares and selling them for coins. That takes coins out of circulation and props up the value of the remaining coins—while simultaneously pushing down the value of shares.

This system should work as long as the market expects the total demand for coins to rise in the future. If the market expects coin demand to rise over the long run, it will see shares as a profitable investment opportunity and so there will be a robust market for shares the system can use to prop up coins' value during temporary downturns.

But this system could fail catastrophically if markets start to expect a long-term decline in demand for coins. In that case, we would expect the value of shares to fall over time. Attempts to prop up coin values by selling shares would simply cause share prices to fall faster, leading to panic-selling and a further downward spiral. As shares get cheaper, the system would have to create more and more shares to keep coins at $1, potentially leading to share hyperinflation and ultimately to the collapse of the system.

Designing for a high inflation rate will cut back on the desire to hoard this as an investment interest. The desire to hoard and see where Bitcoin is headed has driven a lot of the demand - and hence value for Bitcoin. I'm not sure a new currency is going to be stable without some prospectors.

I'm not really up to date on all of this, but I did previously see discussion of people paying 0.00000n01 Bitcoins to buy something. With the current "real life" currencies, it's very hard to pay less than X0.01 - and this acts as a floor to the perceived value of X1. So, does there need to be a limit on how much you can divide a stablecoin?

There is VERY good value, and hence money to be made, with a blockchain based escrow system. But for that to really work, one needs to take out the volatility of the token. Mild inflation is generally good for that, but deflation would be the death of such a system.

Experiencing the rise of crytocurrency over the past decade has really helped to explain why our banking system operates the way it does. Every new cryptocurrency creeps closer and closer to a virtual copy of the fiat currency banks. At what point is it essentially another credit card?

I think the author is mistaken in saying that the shares in the Basis system play no role in stabilizing the value of the currency.

First off, I think the author hasn't clearly understood that bonds in the Basis system are the same as shares in the SS system. Second, the author hasn't provided, or hasn't obtained, necessary details on how dividends are paid to shareholders.

Shares are bought with coins, and then later, coins flow back to the shareholders. So, on the face of it, the shares do play a role in stabilizing the currency. Only, the shareholders keep their shares even after receiving dividends, and the dividends are calculated with an unknown mechanism.

Depending on how dividends are calculated, maybe it's possible that the the shares serve a fine tuning role in adjusting the currency? If the rate of return of the bonds is set when they're bought, it can't be changed, but the dividends could be made lower or higher.

There is VERY good value, and hence money to be made, with a blockchain based escrow system. But for that to really work, one needs to take out the volatility of the token. Mild inflation is generally good for that, but deflation would be the death of such a system.

At the end of the day, aren't the parties in an escrow situation still humans? If the recipient is untrustworthy and says "nope, it never came" and refuses to sign off on releasing the escrow'd funds, how does a blockchain help?

What specific benefits does using a cryptocurrency bring in an escrow situation?

I think the author is mistaken in saying that the shares in the Basis system play no role in stabilizing the value of the currency.

First off, I think the author hasn't clearly understood that bonds in the Basis system are the same as shares in the SS system. Second, the author hasn't provided, or hasn't obtained, necessary details on how dividends are paid to shareholders.

Shares are bought with coins, and then later, coins flow back to the shareholders. So, on the face of it, the shares do play a role in stabilizing the currency. Only, the shareholders keep their shares even after receiving dividends, and the dividends are calculated with an unknown mechanism.

Depending on how dividends are calculated, maybe it's possible that the the shares serve a fine tuning role in adjusting the currency? If the rate of return of the bonds is set when they're bought, it can't be changed, but the dividends could be made lower or higher.

You can correct me if I'm wrong, but I don't think it's true that "shares are bought with coins." That's how SS works, but the Basis system only sells bonds to stabilize the value of coins, not shares.

BUT, I do not see anything that would prevent Basis (as a company behind this stablecoin, one who decide when to issue more coins or sell for shares) to do same financial malversation as Tether - namely, issue 10 million new 'basis' stablecoins, buy $10mil value of bitcoins to raise bitcoin price for example 30%, then sell bitcoins back for 13 million 'basis' stablecoins , and return 10 mil stablecoins to system (use them to buy bonds/shares or whatever is practice used for overvalued coin) - while keeping profits to themselves.

Above action has two benefit for Basis as a company: they earn lot of money (illegally), and they increase number of their stablecoins in circulation.

TL;DR: Who controls how many new stablecoins are issued, or when and how they are exchanged for shares/bonds? If that is done by Basis company, they have open field to do same malversations as Tether company .. even easier, since Tether at least need to pretend they have actual dollars backing tether at all times.

I thought the point was to be unlinked from fiat currencies, which can (at least in theory) be devalued on a whim.

What cryptocurrencies need is a currency who's value changes more slowly so that it can be used as a reliable store of value, at least in the short to medium term.

There's probably no such beast. For a currency to have value, it has to be tied to something. Bitcoin not being tied to anything other than hysteria has meant wild fluctuations. Tying it to a commodity would reduce fluctuations, but not by a whole lot depending on the commodity (see the gold standard). And then you also have the reserve problem that TFA article mentioned. And if you tie the value to a currency, well, you've got this.

Basically cryptocurrencies are a solution in search of a problem. They currently aren't suitable as a currency because of the fluctuations and if they solve that they lose all of the "benefits" a cryptocurrency is supposed to have and don't gain anything. You're really better off holding the actual currency than a peg.

Well, I'd have to describe this cryptocurrency design as possibly the least bad design. But that's more a statement about how terrible other designs are.

Pegging a currency directly to another currency instead of having a floating exchange rate adds a lot of negatives that aren't always immediately considered. Everyone's always so concerned about the dot com and housing bubbles. Why does no one seem to remember the Asian Financial Crisis?

I think the author is mistaken in saying that the shares in the Basis system play no role in stabilizing the value of the currency.

First off, I think the author hasn't clearly understood that bonds in the Basis system are the same as shares in the SS system. Second, the author hasn't provided, or hasn't obtained, necessary details on how dividends are paid to shareholders.

Shares are bought with coins, and then later, coins flow back to the shareholders. So, on the face of it, the shares do play a role in stabilizing the currency. Only, the shareholders keep their shares even after receiving dividends, and the dividends are calculated with an unknown mechanism.

Depending on how dividends are calculated, maybe it's possible that the the shares serve a fine tuning role in adjusting the currency? If the rate of return of the bonds is set when they're bought, it can't be changed, but the dividends could be made lower or higher.

You can correct me if I'm wrong, but I don't think it's true that "shares are bought with coins." That's how SS works, but the Basis system only sells bonds to stabilize the value of coins, not shares.

A glance at the white paper seems to back you up. It says that the number of shares is fixed at the genesis of the system, with their value reflecting the size of the dividends. So, I guess you can buy them with whatever you want on whatever market they're available.

Also, I think there are a couple of key points not in the write-up. The bonds have an expiry date of five years, which the authors of the white paper say will prevent the problem of people not buying bonds towards the end of a slump. Second, new coins are paid out to miners, as in other currencies, but to shareholders.

I thought the point was to be unlinked from fiat currencies, which can (at least in theory) be devalued on a whim.

What cryptocurrencies need is a currency who's value changes more slowly so that it can be used as a reliable store of value, at least in the short to medium term.

There's probably no such beast. For a currency to have value, it has to be tied to something. Bitcoin not being tied to anything other than hysteria has meant wild fluctuations. Tying it to a commodity would reduce fluctuations, but not by a whole lot depending on the commodity (see the gold standard). And then you also have the reserve problem that TFA article mentioned. And if you tie the value to a currency, well, you've got this.

Basically cryptocurrencies are a solution in search of a problem. They currently aren't suitable as a currency because of the fluctuations and if they solve that they lose all of the "benefits" a cryptocurrency is supposed to have and don't gain anything. You're really better off holding the actual currency than a peg.

A currency doesn't need to be tied to anything to have value. To have value it needs people to believe it has value, for them to believe it will continue to hold value into the future, and for the approximate amount of value to be roughly agreed upon by parties engaged in an exchange. The easiest/laziest way to do this is by tying it to something. However, USD's value comes from the fact that people generally believe and trust that other people will accept greenbacks in exchange for goods and services. The fact that the government "guarantees" it by accepting it in transactions itself helps, but there's plenty of failed currencies that prove that's not what gives it value.

I thought the point was to be unlinked from fiat currencies, which can (at least in theory) be devalued on a whim.

What cryptocurrencies need is a currency who's value changes more slowly so that it can be used as a reliable store of value, at least in the short to medium term.

There's probably no such beast. For a currency to have value, it has to be tied to something. Bitcoin not being tied to anything other than hysteria has meant wild fluctuations. Tying it to a commodity would reduce fluctuations, but not by a whole lot depending on the commodity (see the gold standard). And then you also have the reserve problem that TFA article mentioned. And if you tie the value to a currency, well, you've got this.

Basically cryptocurrencies are a solution in search of a problem. They currently aren't suitable as a currency because of the fluctuations and if they solve that they lose all of the "benefits" a cryptocurrency is supposed to have and don't gain anything. You're really better off holding the actual currency than a peg.

A currency doesn't need to be tied to anything to have value. To have value it needs people to believe it has value, for them to believe it will continue to hold value into the future, and for the approximate amount of value to be roughly agreed upon by parties engaged in an exchange. The easiest/laziest way to do this is by tying it to something. However, USD's value comes from the fact that people generally believe and trust that other people will accept greenbacks in exchange for goods and services. The fact that the government "guarantees" it by accepting it in transactions itself helps, but there's plenty of failed currencies that prove that's not what gives it value.

Respectfully, I'm going to seriously disagree. While government backing isn't always sufficient for a currency to be useful, it is necessary. The only other tradeable forms of value besides currencies are commodities and they come with a whole basket full of their own problems. And the failures with cryptocurrencies demonstrate how poorly currencies fare when they don't have government backing.

Generally, when currencies have failed, it is because the government backing them has also failed, if not totally then at least in its ability to manage its finances. Successful currencies have much more than just belief that the currency is useful, there are central banks, taxation and other institutions that actively manage the value of the currency and keep it stabil-ish. You can view that as a good thing or a bad thing, but currencies are definitely supported by much more than just belief.

I thought the point was to be unlinked from fiat currencies, which can (at least in theory) be devalued on a whim.

What cryptocurrencies need is a currency who's value changes more slowly so that it can be used as a reliable store of value, at least in the short to medium term.

There's probably no such beast. For a currency to have value, it has to be tied to something. Bitcoin not being tied to anything other than hysteria has meant wild fluctuations. Tying it to a commodity would reduce fluctuations, but not by a whole lot depending on the commodity (see the gold standard). And then you also have the reserve problem that TFA article mentioned. And if you tie the value to a currency, well, you've got this.

Basically cryptocurrencies are a solution in search of a problem. They currently aren't suitable as a currency because of the fluctuations and if they solve that they lose all of the "benefits" a cryptocurrency is supposed to have and don't gain anything. You're really better off holding the actual currency than a peg.

A currency doesn't need to be tied to anything to have value. To have value it needs people to believe it has value, for them to believe it will continue to hold value into the future, and for the approximate amount of value to be roughly agreed upon by parties engaged in an exchange. The easiest/laziest way to do this is by tying it to something. However, USD's value comes from the fact that people generally believe and trust that other people will accept greenbacks in exchange for goods and services. The fact that the government "guarantees" it by accepting it in transactions itself helps, but there's plenty of failed currencies that prove that's not what gives it value.

Respectfully, I'm going to seriously disagree. While government backing isn't always sufficient for a currency to be useful, it is necessary. The only other tradeable forms of value besides currencies are commodities and they come with a whole basket full of their own problems. And the failures with cryptocurrencies demonstrate how poorly currencies fare when they don't have government backing.

Generally, when currencies have failed, it is because the government backing them has also failed, if not totally then at least in its ability to manage its finances. Successful currencies have much more than just belief that the currency is useful, there are central banks, taxation and other institutions that actively manage the value of the currency and keep it stabil-ish. You can view that as a good thing or a bad thing, but currencies are definitely supported by much more than just belief.

So, a pre-paid credit card which you can already pickup anywhere and refill at will. You say no needing a bank account but yes you still need a bank account for the Bitcoin. You have to have the cash you own get to the person that is giving you the coin which means it has to come from somewhere. With a pre-paid card you can at least go to Walmart or whatever and pay them the cash to refill it with. Actually using bitcoin as your pre-paid card gets you more requirements for banking because again, unlike the refillable Visas you can get and refill at Walmart, there is no place you can go to to pay cash to get bitcoin.

Any thoughts on Maker Dai? It has a pretty good record to this date and has a remarkable level of decentralization.

I thought about covering other stablecoin projects—Maker Dai and Steem Dollars are the two that I probably would have mentioned—but decided not to to keep the article a manageable length.

Maker Dai seems to be working pretty well, but the question with a project like this is what happens in a black swan event. The risks tend to get larger as the absolute size of the money supply gets larger (since crashes are more likely to trigger broader system-wide panic), so the fact that it has weathered downturns so far doesn't necessarily prove that it will do so in the future if more widely used.

Well, I'd have to describe this cryptocurrency design as possibly the least bad design. But that's more a statement about how terrible other designs are.

Pegging a currency directly to another currency instead of having a floating exchange rate adds a lot of negatives that aren't always immediately considered. Everyone's always so concerned about the dot com and housing bubbles. Why does no one seem to remember the Asian Financial Crisis?

I don't think losing control of monetary policy is that big of an issue for this sort of system. It's not like a geographically separate nation is using the currency. The individuals using Basis by and large would otherwise use USD and be involved in the US economy, so US economic trends will likely be mirrored in exchanges using Basis.

Well, I'd have to describe this cryptocurrency design as possibly the least bad design. But that's more a statement about how terrible other designs are.

Pegging a currency directly to another currency instead of having a floating exchange rate adds a lot of negatives that aren't always immediately considered. Everyone's always so concerned about the dot com and housing bubbles. Why does no one seem to remember the Asian Financial Crisis?

The Asian financial crisis was triggered by a balance of payments problem. These economies had high debt (which led to high inflation, relative to the US), free capital movement, and a dollar peg. This is impossible to maintain in the long-term. There is a well-establish concept in international economics called the impossible trinity, which basically posits that you cannot simultaneous have all three of the following:(1) a fixed foreign exchange rate;(2) free capital movement (absence of capital controls); and(3) an independent monetary policy (i.e. interest rate/inflation)

Obviously, Basis must have #1 and #2 to actually be useful. Therefore, they must surrender monetary policy (#3) to the Federal Reserve. In theory, it should be possible to mimic Federal Reserve policy. In practice, I'm not sure the company would be willing to shaft their investors for the long-term stability of their currency peg.

Edit: It is basically a question of whether the company issuing Basis has the resolve (or courage) to maintain the peg at a cost to either itself or its investors. I am highly skeptical.

And the advantages of owning a “stablecoin” over an actual dollar are...?

I do not see anything that would prevent Basis (as a company behind this stablecoin, one who decide when to issue more coins or sell for shares) to do same financial malversation as Tether - namely, issue 10 million new 'basis' stablecoins, buy $10mil value of bitcoins to raise bitcoin price for example 30%, then sell bitcoins back for 13 million 'basis' stablecoins , and return 10 mil stablecoins to system (use them to buy bonds/shares or whatever is practice used for overvalued coin) - while keeping profits to themselves.

Above action has two benefit for Basis as a company: they earn lot of money (illegally), and they increase number of their stablecoins in circulation.

TL;DR: Who controls how many new stablecoins are issued, or when and how they are exchanged for shares/bonds? If that is done by Basis company, they have open field to do same malversations as Tether company .. even easier, since Tether at least need to pretend they have actual dollars backing tether at all times.

I'm pretty sure the idea is that this would be done autonomously by the Basis blockchain, which the Basis company would have limited control over post-launch—the same way Bitcoin core developers can't make significant changes to the bitcoin protocol without a broad consensus. Obviously we'll have to wait and see if that kind of community emerges around the network.

BUT, I do not see anything that would prevent Basis (as a company behind this stablecoin, one who decide when to issue more coins or sell for shares) to do same financial malversation as Tether - namely, issue 10 million new 'basis' stablecoins, buy $10mil value of bitcoins to raise bitcoin price for example 30%, then sell bitcoins back for 13 million 'basis' stablecoins , and return 10 mil stablecoins to system (use them to buy bonds/shares or whatever is practice used for overvalued coin) - while keeping profits to themselves.

Above action has two benefit for Basis as a company: they earn lot of money (illegally), and they increase number of their stablecoins in circulation.

TL;DR: Who controls how many new stablecoins are issued, or when and how they are exchanged for shares/bonds? If that is done by Basis company, they have open field to do same malversations as Tether company .. even easier, since Tether at least need to pretend they have actual dollars backing tether at all times.

Isn't the point of systems like these that the monetary policy pegging Basis to the dollar is entirely automated and is agreed on by the network consensus? That would have seem to assuage some of the concerns, though if the market cap is too low large players would still be able to manipulate the rate.